America’s major problem is unlimited spending

Commentary: A rational, national debate is in order

WASHINGTON (MarketWatch) — I felt better about Uncle Sam’s fiscal situation when I read Rex Nutting’s report that “spending is already coming down.” But then I checked the numbers and it was déjà vu all over again. America’s budget problems are as real as ever.

What’s worse, President Obama in his inaugural address appeared oblivious to fiscal problems. He listed new spending programs, but no cuts. Yet America’s major problem is unlimited spending and a Congress that sees no need to trim federal outlays.

The peak year for federal spending was 2009, when total outlays accounted for 25.2% of GDP. In 2010, as the economy began its first full year of recovery, outlays declined to 24.1% of GDP. They remained at 24.1% in 2011, and increased to an estimated level of 24.3% in 2012. The White House will release final numbers in its new budget in February.

True, discretionary spending — defined as spending that is not required by law — declined from 9.4% of GDP in 2010 to an estimated 8.5% of GDP in 2012. Congress is managing to cut something, mostly defense spending. But over the same period, entitlement spending — or mandatory spending — rose from 14.7% of GDP to 15.9%.

Spending is spending, and it harms the economy equally if it is discretionary spending or mandatory spending.

Obama laid out a clear philosophical case for more spending over less spending. That bodes ill for budget reform, especially entitlement reform.

On entitlements, Obama said Americans “reject the belief that America must choose between caring for the generation that built this country and investing in that generation that will build its future.”

But the costs of Social Security and Medicare are growing rapidly. The Congressional Budget Office projects the cost of Medicare to rise from 3.7% of GDP in 2013 to 4.3% in 2022, and then to 14% in 2085.

Last fall CBO raised projected Medicare spending by $136 billion over the next decade due to lower-than-expected productivity and higher-than-expected costs for goods and services.

This is being paid by the young, who have higher unemployment rates and lower levels of savings.

Since 2002 the labor force participation rate of workers 55 and over has increased by 6 percentage points, whereas the labor force participation rate of workers aged 16 to 24 and workers aged 25 to 54 has been declining. The biggest decline in labor force participation rates can be observed for workers aged 16 to 24.

Over the past 10 years, employment has increased among Americans 55 and over by 8.9 million. At the same time, it has declined by 3.1 million in the 25 to 54 age group, and by 313,000 among those aged 20 to 24.

One explanation for the decline in labor force participation and employment can be found in a recent book by University of Chicago economics professor Casey B. Mulligan, entitled The Redistribution Recession: How Labor Market Distortions Contracted the Economy (Oxford University Press, 2012). It provides new evidence that the expansion in entitlement programs since 2007, such as unemployment insurance, the Supplemental Nutritional Assistance Program (formerly food stamps), mortgage assistance, and other means tested programs, have discouraged people from working.

When recipients take jobs, they lose benefits and effectively incur a high marginal tax rate, around 46%. These high marginal tax rates are caused by phaseout levels of benefits at different income levels.

Federal benefits have contributed to a decline in the labor force participation rate. Now 63.6%, it peaked in 2000 and then gradually declined about one percentage point until 2007. Since 2007 the ratio declined by almost three percentage points.

Means-tested entitlement programs have expanded in two ways. Eligibility has increased, and the programs have become more generous.

Take unemployment insurance, for instance. Not only has the number of weeks of unemployment insurance increased from 26 to 99, but more people are eligible for the program.

Then, consider the Supplemental Nutritional Assistance Program, which serves almost 48 million people. The American Recovery and Reinvestment Act of 2009 increased monthly benefits for participants in the program by an average of 15%. For example, most eligible four-person households have been receiving since April 2009 an increase of $80 in their monthly SNAP allotment to spend on groceries.

SNAP was slated to receive $20 billion over five years from ARRA. The stated goal was to boost the purchasing power of recipients and stimulate the economy. Unlike unemployment insurance, which is limited to 99 weeks, SNAP benefits have no time limit.

Obama concluded his inaugural address by saying that “You and I, as citizens, have the power to set this country’s course. You and I, as citizens, have the obligation to shape the debates of our time.”

The big question is the role of government, and America’s spending path. Will we follow the 27 countries of the European Union, where benefits are generous and federal outlays as a percent of GDP average 49%? Yet, as we can observe from their riots and social disturbances, Europeans have not avoided fiscal chaos.

Alternatively, will we return to an era of personal responsibility where entitlements were for the poor? This is not going back decades, but only to 2008, when federal outlays as a percent of GDP were close to the 20% historical average.

A rational, national debate is in order — without pretending that spending is declining and that our problems are already solved.

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